Blockchain was developed as part of the Bitcoin peer-to-peer cryptocurrency (see feature article “Virtual currencies: the other side of the coin”). Bitcoin allows an individual to transfer virtual currency to another person without an intermediary, such as a bank, having to process the transaction. Blockchain is the key technology at the heart of Bitcoin. It uses a decentralised consensus mechanism to verify that the person seeking to transfer Bitcoin actually owns the Bitcoins in question and it can track each step of the transaction (see box “Advantages of blockchain technology”).

Bitcoin maintains a digital ledger (that is, a blockchain) of every single Bitcoin transaction ever completed. The ledger is protected by a complex mathematical algorithm that verifies the ownership of the Bitcoins. This public ledger is decentralised and stored on every computer that downloads the Bitcoin software. Each time a Bitcoin transaction is successfully verified and completed, every copy of the ledger is updated accordingly.

Unfortunately, the association in the public’s mind between blockchain and Bitcoin could, at least initially, prove to be a stumbling block to the wide acceptance and adoption of blockchain technology. The use of Bitcoin in the so-called “dark web” and as the anonymous currency of choice for criminals may deter potential investors and customers. In addition, Bitcoin suffers wild fluctuations in its valuation, which may lead some to believe that the technology behind it is not reliable.

However, there is an important distinction between Bitcoin and the blockchain technology that underpins it. Bitcoin is the actual digital currency that can be exchanged for a variety of goods and services, while blockchain is the underlying cryptography technology that is applied to the Bitcoin protocol to offer verifiability, reliability and trust in digital economy transactions.

Blockchain technology has many possible applications outside of Bitcoin. Innovative companies that can leverage the cryptographic protocols of blockchain could use it to authenticate the exchange of almost anything, provided that the “thing” can be recorded in a register in the form of an asset.

While still at an early stage of development, blockchain has the potential to transform a range of industries, such as financial services, financial technology (fintech), real estate and professional services. Advocates of blockchain claim that incorporating the technology into existing practices could reduce costs, improve service delivery and streamline a variety of digital processes. On 16 June 2015, Santander InnoVentures, in collaboration with Oliver Wyman and Anthemis Group, published a report which calculated that blockchain could slash settlement, regulatory and cross-border payment costs by $15 to 20 billion each year by 2022 (http://santanderinnoventures.com/fintech2/).

Government. On 19 January 2016, the Government Office for Science published a report setting out the benefits of distributed ledger technology and recommendations for its widespread application by the government (www.gov.uk/government/publications/distributed-ledger-technology-blackett-review). It notes that blockchain and digital distributed ledger technologies have the potential to help governments collect taxes, deliver benefits, issue passports, record land registries, assure the supply chain of goods and generally ensure the integrity of government records and services. Smaller, more nimble economies like Estonia are already developing blockchain technology to store health records securely, vote electronically and provide public e-notary services.

Banking. As blockchain technology removes the need for intermediary financial institutions, and allows parties to transfer assets more quickly at a reduced cost, it may pose a major threat to traditional bricks and mortar financial institutions that do not adapt or respond to it. However, many banks and financial institutions are already investing millions in developing and testing blockchain technology in order to consider how they can incorporate it into their e-commerce and cryptocurrency strategies. For example, on 22 January 2016, the Australian Stock Exchange announced that it was developing a blockchain and distributed ledger solution to replace its current platform for clearing and settling trades. Similarly, Bank of America has reportedly filed a number of US patents in relation to protecting its blockchain-related technology and inventions.

Registries. For lawyers and anyone who needs to be able to trust electronic registers and databases, blockchain could become very important. In simple terms, a blockchain-based document or registry is shared among its users and requires any changes to be verified by all of those users, making it more secure and tamper-proof than existing solutions. This in turn decreases errors and fraud while simultaneously reducing the cost of traditional paper-based processes. The Republic of Honduras is considering a prototype blockchain-based land registry that it hopes will reduce instances of the official land register showing two individuals holding title to the same property.

Smart contracts. Legally binding contracts are the building blocks of finance and commerce. A smart contract built on blockchain technology could provide parties with a cryptographically secure replacement for traditional business documents for everything from wills, to corporate share purchase agreements, to real estate conveyances. In legal transactions, blockchain technologies could be adapted to track the location of a contract, record an undisputable history of changes to a contract, and to verify electronic signatories.

Large technology multinationals, such as IBM, are developing self-executing smart contract programmes that use blockchain technology. In IBM’s platform, the blockchain database hosts the secure smart contract along with an algorithm specifying the execution rules. Once the execution rules are met, the contract is executed automatically. An obvious benefit of no one party controlling the self-executing contract is that all parties can trust it. Other potential benefits may arise with the wider uptake of smart contracts, such as lower compliance costs and scalability.

Even though blockchain technology has the potential to offer tamper-proof and transparent digital economy transactions, there is a current lack of consensus on the standards and versions of blockchain to adopt. In addition, blockchain currently lacks a central legal entity or overall governance regime. While banks and financial institutions are subject to a myriad of rules and regulations, the parameters of government regulations and laws around the use of blockchain and distributed ledger protocols, whether in financial services or other situations, are still being established.

The current battle between rival blockchain standards and platforms vying for adoption can be compared to the rivalry between VHS and Betamax videotapes in the 1980s. Potential users and investors in blockchain may be reluctant to invest in the technology until the industry settles on a single standard. It is unclear when this will happen.

The pressing question for policymakers and regulators is how quickly and to what degree they should be regulating the fledgling technology. One industry commentator recently quipped that imposing harsh regulatory rules on blockchain at this point would be like regulating Alexander Graham Bell’s first telephone in the 1870s. On the other hand, the absence of hard and fast legal and regulatory rules does add to the concern for early adopters and policymakers.

UK approach. Although the use of blockchain is not currently a specified regulated activity under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544), any use of blockchain should be examined on a case-by-case basis to establish whether it falls within an existing regulated activity, such as operating a multilateral trading facility or conducting regulated payment services activities. The Financial Conduct Authority (FCA) appears to be adopting a “wait and see” stance, and is currently limiting itself to discussing blockchain with regulators in other jurisdictions. This could be with a view to fostering innovation and allowing the blockchain technology to evolve and grow before the FCA starts to consider regulating areas such as data transfer, storage, privacy and security.

Irish approach. Unlike in the UK, the Central Bank of Ireland has not formally commented on the approach that it will take to blockchain as applied to financial services or adapted for other uses. Similarly, the Law Society of Ireland has not set out its official view on smart contracts that incorporate blockchain. However, the Irish government’s International Financial Services Strategy 2020 paper places a significant emphasis on fintech and seeks to continue to develop and grow Ireland as a global fintech hub (www.finance.gov.ie/IFS2020). With the support of the Fintech and Payments Association of Ireland, the Irish government is incentivising financial services organisations to invest in innovation, research and development in fintech, including blockchain.

EU approach. Blockchain is certainly on the radar of EU regulators from a financial services perspective. In January 2016, the European Commission (Commission) commented that it would adopt the approach of seeking to understand and monitor virtual currencies, Bitcoin and blockchain, as opposed to directly regulating them. The Commission is taking a cautious attitude, arguing that too little is known at this stage about blockchain and its derivatives to justify new laws beyond standard anti-money laundering requirements when the technology is used in virtual currencies. In line with the Commission’s view, the European Central Bank’s Eurosystem’s consultative report indicates that Eurosystem will, for the time being, assess the relevance of blockchain for payments, securities settlement and collateral (www.ecb.europa.eu/paym/t2/shared/pdf/professionals/RTGS_services_consultative_report.pdf).

The European Digital Currency and Blockchain Technology Forum was recently set up as a public policy forum to consider virtual currencies and distributed ledger technologies. Its vision is to shape regulatory and policy agenda for virtual currencies and distributed ledger technologies in the EU by engaging with policymakers, legislators and stakeholders. It could become a prominent thought leader in the sector.

Philip Nolan is a partner, and Mark Adair is a senior associate, at Mason Hayes & Curran.